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January 27, 2004

Outsourcing - From The Shill's Mouth

This article on outsourcing is a skillfully crafted work of fact and fiction.

Let's do a little deconstruction and not let The New Republic do our thinking for us.

But, like the fears that surrounded NAFTA, those around offshoring are mostly baseless.

This is where the spin starts. The author hasn't presented a case yet he's reached a conclusion.

While offshoring is definitely an economic trend, there is no statistical evidence pointing to the massive employment drain activists call the "coring out" of America's best jobs.

There is however statistical evidence of an overall reduction in these outsourced jobs. Note the author uses the qualifying term "massive." This allows the gullible reader to misunderstand the argument and go into battle with the protectionists with false armor. No, the trend thus far doesn't show massive job reduction, but taking a snapshot of a trend in the beginning gives you absolutely no accurate predictive capability for how the trend will develop over time.

In fact, recent studies show that the opposite is true: While offshoring may displace some workers in the short term, in the medium and long terms it represents a net benefit for both domestic businesses and their workers.

The unstated proposition is that the conditions of previous studies will hold true for the current situation. The author hasn't addressed this premise at all, so the recent studies haven't been shown to be relevant. I'll address some of the remaining assumptions later in the post.

In fact, the greatest threat from outsourcing is that its opponents will use it to force a new wave of protectionism.

Here the author speaks of a very real possibility. Whether it would be the greatest threat is a value judgement, but the fact that protectionism reduces economic efficiency is well understood in economics.

"There's just a lot of anecdotal evidence." Some point to the jobless recovery as evidence of offshoring's impact, but the lack of jobs is just as likely the result of booming productivity and the economy's (until recently) anemic pace. "I think people are confusing the business cycle with long-term trends," says Daniel Griswold, an economist at the Cato Institute. "People are looking for someone to blame. They say, 'Aha, it's because our jobs are moving to India.' If you look at the late 1990s, though, all these globalizing phenomena were going on." In other words, it wasn't that offshoring practices changed; it was that the economy slowed.

I'd agree with this statement. There are disincentives to staffing if you don't fully maximize your personnel. There is still plenty of slack left in the system with existing personnel and the safer bet is to use them to their fullest before the necessity and expense of hiring additional staff must be incurred. Job creation is a lagging indicator.

The hysteria about outsourcing makes for good drama, and thus political theater. As the article points out, it is still too early to tell what the trend is and what the impact will be.

What's more, economists don't even agree on how such data could be collected--for example, many offshoring moves represent not a direct shift of a given job overseas but rather its restructuring, which in turn might create a new job overseas as well as a new job, with a new job description, in the United States. Such restructuring is particularly prevalent in high-tech fields like software and data management--for example, an American employee might be tasked with the design, implementation, and testing of a software program; under restructuring, his employer might hire an Indian, at one-tenth the cost, to do the implementation and testing and then hire an American to do the design work.

First off, the point about how to measure this phenomena is quite valid. Disaggregating the labor data is most likely impossible. Perhaps an academic could study the process at some selected companies and extrapolate a projection for the economy as a whole but the validity of the extrapolation would pretty much be equivalent to voodoo.

The author is being quite disingenuous when he states that an employee that used to do the design, implementation, and testing of a software program and loses his job to outsourcing could be counted as gaining a new job dealing strictly with the design work. First off, if someone is performing 3 interdependent tasks as part of their responsibilty, then they cannot perform only one task at full capacity. Either the firm has outsourced 1,000 similar jobs and now needs 300 new full-time design engineers (having made 700 engineers redundant) or it creates a job for a design engineer and hires additional staff in the outsourcing country, or the design engineer is underutilized.

In answering the critics of outsourcing the author has quite correctly pointed out that they lack data to support their case, yet he has no qualms about blowing smoke up our ass with unsubstatiated scenarios like the one above. He too lacks data, so this part of his argument is pure spin.

IBM, for example, plans to offshore 3,000 programming jobs this year. But, at the same time, it will also create 5,000 jobs in the United States. Does that count as jobs lost, jobs gained, or both? "[Offshoring is] going to lead to individual job loss," says Gary Burtless, an economist at Brookings, "but that does not mean it will lead to aggregate loss of employment in the United States."

Here the author spins a story that should quell the critics. Look more jobs will be created than lost. He notes that type of jobs that will be lost - programmers -but gives no details of the jobs to be created. We'd hope that they would be at IBM labs where the former programmers can go after upgrading their training and there they could be put to more productive use. For all we know they could be creating 5,000 call center jobs that would clearly be a step down for the programmers.

Gary Burtless is correct when he points out that the causality between individual job loss leading to an aggregate job loss hasn't been established. By placing the comments of Gary Burtless within this paragraph the author seeks to lend support to his example. The two strands of the paragraph are completely unrelated.

We can pretty much disregard the hypothetical example used, and take Mr. Burtless at his word that he doesn't know what will happen. Heck, I don't know what will happen either.

Even if there were a short-term loss of jobs, the losses would likely have a more muted effect on the economy than the factory flight of the 1980s and '90s, when most factory workers had to undergo intensive retraining in order to find new jobs. White-collar workers tend to be, both in terms of skills and career perspective, more capable of moving on to other jobs.

This is an acknowledgement of cognitive talent. A very good point but don't neglect the fact that new jobs that are created for these people could also be created in the outsource countries. For those jobs to be created in the US, the employees would have to be better trained than their foreign competition. Didn't they just lose their jobs because their training was equivalent to their foreign competitors? Keep in mind that if they can retrain, so too can the outsource competitors.

Also many of those who have lost their jobs are well into their careers and the distortions within the labor market make hiring workers over the age of 50 very unattractive because of the health insurance issue. This is but one example of external forces acting on market forces and I'll go into this more towards the end of this essay.

The subset of unemployed workers that could benefit would be those who could, and do, seek retraining, and are fortunate enough to have made the prescient decision of choosing the correct field of training and further, to be hired by a company that is breaking new ground in that field.

That employee is now on the coattails of a company that has a comparative advantage over its foreign competitors, in large part because of the employee's unique skill sets.

For this paragraph I'd say the author is spinning the case once again for he's not saying anything substantive but just trying to reassure his audience of the purity of the ideological message sans facts.

Another mitigating factor is the wide dispersal of high-tech jobs throughout the country; unlike manufacturing, which tends to clump hundreds or thousands of jobs in the same factory or town, high-tech work can be done anywhere. For example, one of the job sectors frequently cited as "offshoring prone" is medical transcription. Although it's a $15 billion industry, medical-transcription work is almost always farmed out to small firms around the country; even if all of them closed, the impact on any one community would be small.

He's reaching with this one. A new frame of reference is introduced - the community. Previously we were discussing individual dislocation but now we're relieved that the individual dislocation won't be concentrated within one community. This does nothing to the aggregate dislocation and because whole communities are affected, the dislocations will be more difficult to politicize.

Yes, his argument does mitigate against concentrated job loss but does not explain away the aggregrate job loss. In the end, this is a moot point.

"The lower-level jobs, the programming jobs, a lot of them will not be done in this country," says Stephanie Moore, an outsourcing expert at Giga, an economic research firm. In their place, she says, "New jobs are going to be created.

I don't necessarily disagree. This could very well be the case, however her statement is one of pure faith. If the reader is prone to persuasion by appeal to authority, then the quote will be reassuring, otherwise it's just hot air.

According to the McKinsey Global Institute, for every dollar a U.S. company spends on offshoring to India, the U.S. economy gains $1.14, thanks to a number of factors: savings from the increased operational efficiency, equipment sales to Indian outsourcers, the value of American labor reemployed to higher-wage jobs, and repatriated earnings by U.S. companies that own Indian outsourcing firms.

Did the writer get paid by the word? Is that why he's filling with this vacuous quote?

savings from the increased operational efficiency - Very true.
equipment sales to Indian outsourcers - no dependency established
American labor reemployed to higher-wage jobs - too presumptuous
repatriated earnings by U.S. companies that own Indian outsourcing firms - data too fluid

"The choice isn't outsourcing or keeping jobs here," says Griswold. "It's outsourcing or going out of business. Which isn't good for jobs. This is an absolute necessity for many companies." If companies were somehow prevented from shipping jobs offshore, they would likely turn to other methods of reducing labor costs, such as technological upgrades--a process that has resulted in job loss since the birth of capitalism.

Very disingenuous rhetoric. "It's outsourcing or going out of business." Consider this extreme example - I need to firebomb my competitor or I'm going out of business. Clearly, such behavior is illegal. Illegaility puts a course of action out of the realm of possible alternatives. If outsourcing is not an option, for whatever reason, then it isn't an option for all of the firm's competitors either. If competitive pressure to outsource is at the root of the dilemma, then absent such pressure the dilemma doesn't exist. Bad argumentation on the author's part. Pure spin.

As for the secondary argument that technology would simply replace outsourcing, this too is on weak ground. The case was much stronger for manufacturing, but it is difficult to have technology replace a programmer or an engineer. Moreover, if technology is developed that increases the productivity of an engineer or programmer, then at least the displaced professionals can marginally increase their training to once again be proficient in their field rather than retraining for an entirely different field that can staunch the assault of lower waged-similarly skilled foreign competition. Here as well, the author fails to adequately make his case.

But, while offshoring-related protectionism may stifle economic development and unnecessarily force business closures, its biggest impact may be longer term. That's because, as the baby-boomers move into retirement, the size of the working population will decline precipitously, by 5 percent by 2015, according to the McKinsey report. Without a readily available source of high-quality, young labor--i.e., the sort provided by offshore outsourcing--the country could find itself in a sort of economic sclerosis.

They're pulling every skungy rabbit out of the hat. This argument isn't even coherent. The young labor provided by offshore outsourcing provides absolutely no benefit for the US social safety net. These workers wouldn't be paying into Social Security nor paying US income tax! This is conflating the situation to make it appear as though the outsourced labor were actually in the US and thus helping alleviate the US demographic timebomb. Failing grade on this point.

Growth could be permanently hamstrung by the high labor costs and booming social spending that have turned Germany, where it's extraordinarily difficult for companies to lay off employees, from an economic engine into a plodding giant.

The author hasn't established a causal relationship so this conclusion can't be attributed to the preceding argument. However, constraints on markets do inhibit growth and they are obstacles to efficiency. That doesn't though, excuse the sloppy reasoning skills employed in this argument. They should work on this argument and tighten it up some more. Failing grade, but with potential.

Nevertheless, the fact that there are benefits to offshore outsourcing doesn't mean we should sit back and let it ride. At the individual level, job loss is a painful process, and there is no guarantee that even a relatively mobile white-collar worker whose job is outsourced will be able to find a new one, let alone at the same wage. The response, however, isn't to fight against offshoring but to find ways to alleviate its negative effects. One approach--advocated by Lori Kletzer, a senior fellow at the Institute for International Economics, and Robert Litan of the Brookings Institution--is to require companies to purchase "outsourcing insurance," which would cover a portion of displaced employees' salaries for a fixed period of time in the event their jobs are outsourced. Not only would this help alleviate the pain of layoffs, but it would force companies to internalize the economic cost of their outsourcing decisions. The McKinsey report, which also favors this approach, argues that, "as offshoring volumes rise, the insurance premiums will increase, cutting into the gains from offshoring and, thereby, making offshoring less attractive to companies in periods of high unemployment."

Outsourcing insurance is just a market contaminant. It is a legislative salve. It is an external cost imposed by society. In essence it is a chimera, for while it pays heed to market forces and allows companies the choice of whether they wish to incur the cost of purchasing insurance in order to outsource, it is no different than forcing a company to incur a cost of maintaining employees by prohibiting outsourcing. Both approaches serve to reallocate costs; the former does so my market forces, while the latter does so by fiat.

This is an interesting alternative that the author raises but let's recognize that it is a market distortion just as an outright ban on outsourcing would be.

Consider the case of outsourcing from a different perspective. Foreign pharmacies are performing a service cheaper than American pharmacies. The response of American pharmacies is not based on market principles but is directed to legislative redress. I realize that I'm stretching the comparison, but we seem to always rail against welfare for individuals but never put up the same effort to curtail corporate welfare.

Yes, I know that price caps have been instituted in foreign countries to limit the price of drugs and that is why these foreign countries have a competitive advantage but, and this is an important but, no one is forcing the drug companies to sell their products in those countries. Yes, I know, the companies fear that if they stopped selling their drugs that the foreign patent laws would be amended which would prematurely push the drugs into generic status.

The point for my whole essay is that we often forget to account for the fact that economic systems are fictional creations which are subsumed under the operating conditions society imposes. Just like one cannot fire-bomb a competitor, companies must also operate under economic conditions that are arbitrary.

The foreign price caps imposed on drugs are a market distortion. Rather than letting the American consumer benefit from the lower prices, the pharma industry is trying to ban importation and if that fails, they will exert pressure for the foreign countries to harmonize their laws to ours. The critics of outsourcing could use the same tactics and seek to harmonize foreign conditions to our own. Hey, they already are - that's the whole FAIR TRADE platform. Depending on which side of the ideological chasm you stand you might be inclined to deplore the other side's tactics. I'm saying that neither side is pure here and the tactics have frightening similarities.

There is much efficiency yet to be gained within the economic system if we find more opportunities to outsource. The often unconsidered point is whether the goal is to to achieve a higher state of economic efficiency (which efficiency seek ing and outsourcing do) or to serve the country's best interests (the debate is just starting on whether outsourcing helps on this issue). The two are not always the same and the linked article, as I hope I've demonstrated, is simply advocacy for a position, and weak advocacy at that. At most it seeks to reassure an audience that is predisposed to receiving a comforting message.

Spin, and little else.

Update from Razib: Wired has put this month's cover article about outsourcing to brown-land online....

Posted by TangoMan at 10:07 AM